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The Securities Exchange Act of 1934 (the 1934 Act), 15 U.S.C.S. § 78j, is not violated when a person trades securities without disclosing inside information unless the trader has an independent duty of disclosure. Not every instance of financial unfairness constitutes fraudulent activity under § 78j. The 1934 Act cannot be read more broadly than its language and the statutory scheme reasonably permit. Section 78j is aptly described as a catchall provision, but what it catches must be fraud. When an allegation of fraud is based upon nondisclosure, there can be no fraud absent a duty to speak.
A public building authority issued bonds in 1986 and 1988 to finance public improvements at a planned development, with a bank serving as indenture trustee for the bond issues. The bonds were secured by landowner assessment liens, and the bond covenants required that (1) the land subject to the liens be worth at least 160 percent of the bonds' outstanding principal and interest, and (2) the developer give the bank annual reports containing evidence that the 160 percent requirement was met. After questions were raised about a January 1988 report indicating that the value of the land in question had remained steady since 1986, the bank's in-house appraiser reviewed the report, decided that the listed land values appeared to be optimistic, and suggested a review by an outside appraiser. The bank, however, decided to delay such a review until the end of the year, 6 months after the closing on the bond issue. Before the independent review was complete, the authority defaulted on the 1988 bonds. Purchasers of the 1988 bonds filed an action in the United States District Court for the District of Colorado and alleged that (1) the authority, two underwriters, and a director of the developer had violated 10(b) of the Securities Exchange Act of 1934 (15 USCS 78j(b)), and (2) the bank was secondarily liable under 10(b) for aiding and abetting the other defendants' fraud. The District Court, however, granted summary judgment in favor of the bank. The United States Court of Appeals for the Tenth Circuit, reversing that judgment, expressed the view that (1) a 10(b) aiding and abetting cause of action was available where there was (a) a primary violation of 10(b), (b) recklessness by the aider and abettor as to the existence of the primary violation, and (c) substantial assistance given to the primary violator by the aider and abettor; (2) the bank's awareness of the alleged inadequacies of the 1988 report, and of the fact that purchasers were using the report to evaluate the bond collateral, could support a finding of recklessness; and (3) a reasonable trier of fact could find that the bank had rendered substantial assistance by delaying the independent review (969 F2d 891).
Is aiding and abetting covered by the subject securities exchange acts?
The federal courts have not relied on the "directly or indirectly" language when imposing aiding and abetting liability under § 10(b), and with good reason. There was a basic flaw with this interpretation. According to respondents and the SEC, the "directly or indirectly" language showed that "Congress . . . intended to reach all persons who engage, even if only indirectly, in proscribed activities connected with securities transactions." The problem, of course, was that aiding and abetting liability extends beyond persons who engage, even indirectly, in a proscribed activity; aiding and abetting liability reached persons who do not engage in the proscribed activities at all, but who give a degree of aid to those who do. A further problem with respondents' interpretation of the "directly or indirectly" language was posed by the numerous provisions of the 1934 Act that use the term in a way that does not impose aiding and abetting liability. In short, respondents' interpretation of the "directly or indirectly" language failed to support their suggestion that the text of § 10(b) itself prohibited aiding and abetting. Congress knew how to impose aiding and abetting liability when it chose to do so. If, as respondents seem to say, Congress intended to impose aiding and abetting liability, we presume it would have used the words "aid" and "abet" in the statutory text. But it did not. It was inconsistent with settled methodology in § 10(b) cases to extend liability beyond the scope of conduct prohibited by the statutory text.
To be sure, aiding and abetting a wrongdoer ought to be actionable in certain instances. The issue, however, was not whether imposing private civil liability on aiders and abettors is good policy but whether aiding and abetting is covered by the statute. As in earlier cases considering conduct prohibited by § 10(b), the court again concluded that the statute prohibits only the making of a material misstatement (or omission) or the commission of a manipulative act. The proscription did not include giving aid to a person who commits a manipulative or deceptive act. The court cannot amend the statute to create liability for acts that are not themselves manipulative or deceptive within the meaning of the statute.